In Chapter 4, we saw that the market forces of supply and demand lead to an outcome where all buyers can buy what they want at the posted price, and all sellers can sell what they want at the posted price. In practice, however, buyers and sellers aren’t the only actors in the market: Government policy also shapes how much is bought and sold. The three forms of government regulation we looked at in this chapter—taxes, price regulations, and quantity regulations—are all tools at the government’s disposal to change outcomes.
Taxes, price regulations, and quantity regulations can all be used to achieve the same policy objectives. But each policy typically hurts some constituencies in the process of helping others, and different policies yield different distributional outcomes. For example, you saw that Scotland is reducing the quantity of alcohol consumed by setting a price floor. Other countries tax alcohol to achieve a similar effect—lowering the amount of alcohol consumed by raising the price that buyers pay and lowering the price that sellers receive. Governments also directly limit the quantity of alcohol that people can purchase. For example, people under the age of 21 cannot purchase alcohol in the United States and businesses are often prohibited from selling to inebriated people. Both of these policies limit the quantity of alcohol demanded in the market. Governments also restrict the quantity supplied by limiting the quantity of businesses that can sell alcohol by requiring liquor licenses.
A government can choose any of these policies to achieve a policy goal of lowering the quantity of alcohol consumed. However, the three policies have different distributional effects across buyers and sellers. With the price floor in Scotland, sellers will receive a higher price and buyers will pay a high price. This means that while businesses may struggle to gain market share in Scotland (remember, the quantity demanded is below the desired quantity supplied), the ones that succeed make a nice profit selling at prices well above their marginal cost. When the government uses a tax, the price suppliers receive falls relative to equilibrium. Suppliers sell less and the price they keep after taxes is lower. It’s no wonder businesses prefer price floors over taxes. Notice that taxes raise the after-tax price for buyers while lowering the price sellers receive because they also raise revenue for the government to fund public services. Not surprisingly, almost everyone hates taxes, even if they like the government services the revenue funds.
What about quotas? When the government restricts supply, the lucky sellers who are able to succeed in the market are able to charge higher prices, so like a price floor, sellers benefit more from restrictions that limit supply. However, if the government effectively limits demand, the quantity consumed will decline and so will the price.
In this chapter, we didn’t ask whether the various government policies we examined were a good idea or not. In Chapter 7, we’ll take a deeper look at the benefits generated in the economy for buyers and for sellers. And then in Chapter 10, you’ll see what happens when markets fail to generate as many benefits as are possible for buyers and sellers. Government policy is sometimes a response to pressure from people who are looking out for their own interest and sometimes a desire to correct a market failure. Once you have these tools under your belt, you’ll be better able to decide whether a particular government intervention in the economy is a good idea or not.